Greenspan: We Can Always Print Money, but Can’t Guarantee Purchasing Power

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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.

Coming up we’ll hear from Dr. Pippa Malmgren, former Special Assistant to the President of the United States for Economic Policy and former member of the President’s Working Group on Financial Markets. Dr. Malmgren shares her insights on inflation, gold, and the ramifications of government intervention in financial markets. Don’t miss a fascinating and enlightening interview with this former member of the “Plunge Protection Team”-- coming up after this week’s market update.

Well, Greek intransigence punctuated a strange week of market action. Greece moved closer to the precipice of default by postponing a payment due to the International Monetary Fund. Greek officials will now owe the IMF 1.5 billion euros by end of the month. And they will try to obtain more bailout funds in the meantime. Or exit the Eurozone altogether.

Instead of sparking a sell-off in the euro, the currency rallied against the U.S. dollar through Thursday. The dollar index fell, but neither stocks nor hard assets benefited. Commodity prices trended lower, as did precious metals. And instead of serving as a safe haven, bonds headed down, too. There was nowhere for investors to hide this week except, strangely enough, the euro.

On Thursday, gold prices retreated to the lower bounds of what had seemed an unbreakable trading range. Gold finished just above support at $1,176 an ounce yesterday, but is off this morning and has now broken below that support. It currently trades at $1,167, down 2% on the week.

Silver suffered more severely this week, with prices showing a 4% weekly decline to trade at $16.10 an ounce. The platinum group metals also look lower, with platinum down 2% and palladium down 3.6% this week.

Investors seem unsure how to react to recent economic reports that point to a weakening economy. On the one hand, bad news for the economy is usually bad for stocks and industrial commodities -- and good for bonds. On the other hand, bad news for the economy decreases the odds that the Federal Reserve will raise rates, which could be mean good news for the nominal prices on most assets.

The IMF on Thursday released its annual report on the U.S. economy. It downgraded the outlook for U.S. economic growth from 3.1% to 2.5% in 2015. The IMF was clear about the implications for U.S. monetary policy. It urged the Federal Reserve to defer interest rate hikes until “there are greater signs of wage or price inflation.”

It’s not clear even if 2.5% growth will materialize this year. Last Friday’s GDP revision showed the economy contracted at nearly a 1% rate in the first quarter of 2015. The negative GDP figure would have been even worse were it not for the inclusion of a negative price deflator. According to the government, consumer prices declined overall in the first quarter. Normally, nominal GDP readings are adjusted downward by inflation. But in this case the negative GDP figure would have been even more negative without the adjustment for falling price levels.

Not surprisingly, the official economic data is causing the deflation bugs to come out of the woodwork. They think asset prices will collapse and consumer price levels will fall sharply in spite of Fed chair Janet Yellen’s vow to ensure a positive annual inflation rate.

Deflation bugs sometimes accuse gold bugs of not understanding how the Federal Reserve System works. Deflationists argue the Fed’s hands are somehow tied, that it can’t just print money to avert national bankruptcy. On that issue, they are just plain wrong. The Fed can most certainly print money to keep the system propped up and avert deflation. But don’t take it from me. Take it from someone who knows the Federal Reserve intimately well, having been an insider there for decades. That someone is former Fed chairman Alan Greenspan.

Alan Greenspan: The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default. We can guarantee cash benefits as far out and whatever size you like but we cannot guarantee their purchasing power. Because we can always print money but we cannot guarantee their purchasing power.

So there you have it, straight from the horse’s mouth. The Fed has the ability to keep the government’s Ponzi schemes going, but not the ability to do so while also maintaining the value of the dollar.

The Social Security Administration projects that its so-called trust fund will be depleted by the year 2033. That’s the official, optimistic timeline. Independent economists say Social Security will likely go broke many years before then, with a funding crisis coming in the next decade. Meanwhile, Medicare’s exploding costs are putting it on an accelerated path to insolvency. Medicare’s finances make Social Security’s financial future look cheerfully optimistic by comparison.

But the day of reckoning isn’t here now, so most investors are planning for very low rates of inflation to comfortably persist. Current conditions may persist for a while longer – or even longer than we expect – but they aren’t ultimately sustainable.

If there’s one thing that both the deflation camp and the inflation camp agree on, it’s that our unsustainable debt levels will result in a financial calamity of some sort. The debt can be defaulted on, at least in theory. Or it can be inflated away through “money printing,” as Alan Greenspan put it. In either scenario, you don’t want to be stuck holding a bunch of dollar-denominated IOUs in the form of bonds, and you certainly don’t want to base your entire retirement future on benefits promised to you by politicians.

Well now, for more on the real-world effects of all of these financial shenanigans, let’s get right to this week’s exclusive interview.

Mike Gleason: It is my privilege now to be joined by Dr. Pippa Malmgen, former Special Assistant to the President of the United States for Economic Policy and former member of the President's Working Group on Financial Markets. Dr. Malmgen formerly headed the Global Asset Management business for Banker's Trust in Asia out of Hong Kong, was although the Chief Currency Strategist for Banker's Trust, and the former head of Global Investment Strategy at UBS.

Dr. Malmgen was also a senior consultant to Deutsche Bank and currently advises the largest sovereign wealth funds, hedge funds, and pension funds in the world. She's also the founder of the DRPM Group out of London and author of the new book Signals: The Breakdown of the Social Contract and the Rise of Geopolitics. Dr. Malmgen, thanks for taking the time to visit with us today. I really appreciate you coming on the program.

Pippa Malmgen: Thank you.

Mike Gleason: You have quite an impressive background that I just touched on there in the introduction. In some ways, like Jim Rickards and other guests we've had on here in the Money Metals podcast in recent months, you've been a true insider in the financial establishment in the past, but I also know you have some real concerns about the actions that have been taken in recent years, so let me ask you, was the government's and the fed's response to the 2008 financial crisis successful or are we looking at an even more dangerous situation today?

Pippa Malmgen: This is the interesting question. Looking back, I can see exactly why they felt compelled to intervene in the markets as substantially as they did. The problem is how do you reverse this? I think the bigger problem is they may not even want to reverse it. I think that they feel like markets maybe can't be trusted because it was the people in financial markets that drove the economy into a potential disaster. The regulators and the policy makers grabbed the power away from markets that took control and became the biggest market maker, the price maker in the market. Now, they like that position. This is a bit dangerous because what it means is our policy makers, even in the United States, have lost their faith, their trust, their belief in markets. And that's a pretty dangerous development. So they're reluctant to hand power back to the financial markets. This causes the Chinese and the Russians to say “who's more communist now, by the way? Who's got more state intervention? Who's got less free markets.” They have a point. We should think about this.

Mike Gleason: You touched on Russia and China there. Now we have full-fledged financial warfare underway and you don't have to look any further than US-Russian relations and how we're handling that situation as we try to cut them off at the knees to pressure them to do what we want. How do America's actions in the financial realm relate to the rise in geopolitical tensions, whether it be China, Russia, Iran, or others? Where do you think this is all heading?

Pippa Malmgen: This is the point of writing a book was to explain that there are lots of consequences to the decision to introduce all this money, quantitative easing into the world economy. One of the consequences will be social because when you try to create inflation, the people it will hurt most are the poor and those who don't own assets. The people it helps are the people who own assets, like property, like stocks because those asset prices go up. You create social pressures by doing this. But on a larger scale, it also introduces social pressures internationally.

The view from China and Russia is the US is basically playing Russian Roulette with price stability. In other words, they're willing to take all kinds of gambles with the value of the US dollar in order to deal with the domestic debt problem and the consequences are potentially dangerous for those emerging markets. People who work in emerging markets, they spend 40% to 70% of their income on food, energy, and rent. Now what are the prices that rise when you try to create inflation through quantitative easing? Mainly those.

We have record high prices for beef today. We see record high prices for property. That means rent also. They go “hey, this is happening because you've made the decision to deal with your debt problem in this way”, but the consequences for the poor and emerging markets are very severe. To protect ourselves, we are now going to reach for assets that are important to us. That's one reason we see China being more aggressive in the South China Sea where you have more than 10% of the world's fish supply, which matters in a world of record high protein prices.

It's where you find all the new gas fields. They don't have enough energy. It's why Russia gets much more aggressive about the assets around them, like Ukraine, which is the fourth largest supplier of food in the world. So the link, it's a big jump, but it's important to understand. Geopolitics hasn't returned to the landscape in a random way. It is definitely being influenced by the economic pressures that arise from the decision to engage in money printing, quantitative easing, and generally trying to create inflation.

Mike Gleason: Sticking with the theme of your book here, give us a brief summary of what your goal was in writing it because I know a lot of it had to do with empowerment and giving the everyday investor, business owner, or individual the ability to zero in on what they're worldly experiences in the marketplace are telling them and how to parse through all the noise. Talk about that.

Pippa Malmgen: I've been so lucky, so privileged that I got to work in the White House with some of the smartest people in the global financial markets. What I realized is actually first of all, everybody has the same question. Will interest rates go up or down? Will growth be better or weaker going forward? It doesn't matter if it's the President or your cousin. They all want to know these basic things. Second, that in economics, we have this tendency to talk in math and data points, and complex formulas. In fact, you can put it in plain English. If you do that, people can understand it.

So I wanted to write something that would help a regular person understand how the world economy is working in ways that will touch their lives so they can better manage the ebbs and flows that inevitably happen. Much of the book is about encouraging people to get engaged with the subject. It's not all math and it is important. It will touch your life whether you like it or not. So you might as well learn to manage it, and be part of it. People are always asking me, what's the world's economy of tomorrow going to look like? My answer it all depends on the decisions that you make.

Are you going to be building businesses or taken entrepreneurial risk or trying to create new forms of GDP or are you going to resign yourself and say I'll just let the state take care of me? That's not a great decision, given that the states of most industrialized countries are broke. I just wanted to write something that would help people understand this. To that end, why do we have to only talk about steel and auto parts when we talk economics because it's also about lipstick and high heels and everyday things. Why do burgers cost more? These are real things that matter to people.

Mike Gleason: Now you had some signals of your own and clues leading up to the ‘08 financial collapse, that things were not quite right back then. Before we get back into some of the signals that you're seeing in today's financial markets, talk about that for a moment. What were you seeing back in ‘07 and ‘08 and what were you doing to prepare yourself? Also what kind of response did you get from others?

Pippa Malmgen: I thought throughout the course of 2007, I was arguing that we were about to have something really catastrophic like the savings and loan crisis. In retrospect, it was even bigger than that, but that sounded pretty dramatic at the time. Most people were like, you know Pippa, you need a vacation. I thought the fact that I'm in the deep minority actually gives me greater conviction. I learned that this is one of the things you have to do in markets, if you're going to be an investor, is to do things when everybody else says that it's stupid.

This is why I have a big section in the book on character and why it takes a lot of character because it's going to force you to do something different from everybody else, but if you don't, then you're always with the crowd. That means you buy high and you sell low, which is not where you want to be. If you want to buy low and sell high, you're going to have to say I see something that others don't. What did I see? I saw lots of things. I remember I got stuck accidentally on the kitchenware floor at Bloomingdale's in New York. I just took a wrong turn and ended up going one level higher.

I saw the whole floor covered in Halloween colors painted on China dining sets. There must have been hundreds of them. I remember thinking, who has the money to buy an entire dining room China set that they're going to use one day of each year? Where are they going to store that? Presumably there's one for Christmas and one for Easter and I don't know what. I suddenly realized people are definitely spending more on their houses, on the physical size of them and on what's in them than they can afford. And I thought this is a valid signal. It's not a data point. It's an anecdote, but anecdotes tell us a lot about what's going on in the world.

That's why I'm very big on trying to help people understand what the everyday signals are, coming from magazine covers or events in the market. Actually, I've just launched a video series called Fifty Shades of Economics, which sounds pretty funny, but all it is is a series of video clips on YouTube that describe everyday signals, like when you buy something at the store, like cookies, and now you find that the box is the same size as it used to be, but there are fewer cookies inside. Why is this? It's economic pressure. That's a signal. So that's been my approach.

Mike Gleason: So fast-forwarding to today, we seem to have a bit of a disconnect between some of the economic data released by the various governmental agencies, whether it's the unemployment rate, which keeps falling – all the while, thousands of people drop off the roles and are thus no longer counted as unemployed, even though they haven't found a job – but also when it comes to inflation, which you touched on earlier. Now the government clearly has a perverse incentive to under report inflation. Talk about that and also comment on what the real world realities are showing us there.

Pippa Malmgen: Here's the key. Inflation is a form of default. It's a means by which a government ends up paying back less than they borrowed. So think of it this way. The US government borrows a hundred dollars from overseas investors. They can pay them back a hundred dollars, but what it will buy is less. It will buy fewer stocks because the stock market has gone up. It will buy less of an apartment because the price of an apartment has gone up. It will buy a smaller steak because the price of a steak has gone up.

It’s kind of an expropriation. It's a tax. It's an invisible tax. Some people would say why do pick 2% as the appropriate inflation rate? The honest answer is we pulled the number out of thin air, because it's the number that people won't notice. If your assets are deteriorating or losing value by 2% a year, you can live with that. That's what it is. It's an expropriation of your savings. Governments are having to do this because they're so broke they can't pay off the debt. If you charged every single American 100% of their income in tax, you are still left with a decade long debt problem. That's how big it is.

Now we know governments are desperately trying to create inflation. So what if it works? That's my simple question. What if it works? If it works, we should expect asset prices to go up. We should expect that the cost of living over time will rise. Is government incentivized to tell you this is going to happen? No, they're not. It's interesting, the disconnect as the data says our cost of living is falling, but practically, every dinner, every barbecue you go to, the only thing people are talking about is the rising cost of living, the rising cost of groceries, the rising cost of rent, the rising cost of pretty much everything.

Frankly, even with the oil price having fallen so much, every other price is rising so rapidly, it compensates. I think just recently there was an announcement by Blue Cross that they want to raise the premium on health insurance 26% on average in one year. That is a multiple of the official inflation rate that is less than 2%. This is the thing, you get a disconnect between what the data is telling and what is actually happening in real life. I think the gap between the two is where individuals and investors will make or lose a lot of money. That's why we should pay attention to that gap.

Mike Gleason: Meanwhile, interest rates are being held so artificially low, yet everyday prices on things are rising, as you just mentioned. It's especially painful for those who have to live on their savings or on fixed income. Is this financial repression a deliberate effort to steal wealth from average Americans or are they just hapless victims of policies that favor the Wall Street and banking elite?

Pippa Malmgen: I don't think anybody in the policy world, at the Fed or in the White House has sat around and say, let's dump all the losses in the system on the older savers. That's not how the game works. I've been in those circles. Nobody says let's inflate. What happens instead is that all the options are really awful. They pick the least worst of all the bad options. And in this way, they back into a situation where the net effect of it is you are creating inflation and it is going to hurt the savers more than it hurts the speculators.

In the book, I make reference to a very famous economist in economic circles, called Knut Wicksell, a Swedish economist. What he said is the interest rate is an instrument of justice. And if government tries to push it in one direction, what they're choosing is between the savers on the one side and the speculators. In recent years, because of the financial crisis, the decision was made to definitely favor the speculators over the savers. That's the whole point of quantitative easing. You give free money to the speculators. The very people who lost all the money, you basically write them an open-ended free check. You want them to go speculate with it because that's what drives asset prices up and then causes people to think maybe the economy is getting better. The savers in the meantime are being punished because the return for putting your money in the bank is so low. So part of the point of quantitative easing is to compel the saver to become a speculator. They make you feel stupid when the prices are going up so much and you missed it. There is an element the government has chosen to influence that social justice mechanism and they've chosen the speculators over the savers.

Mike Gleason: What role do you think gold and other precious metals will play as events unfold over the next few years? Will it re-assume its historic role as money or is it just a barbarous relic as some central bankers like to say? What do you see there?

Pippa Malmgen: I think it's got a part to play in a portfolio, that's for sure. Is it the best way to protect yourself if you believe that inflation will be the outcome of this huge effort to create it? Let's be clear, we've never in history seen so many large economies simultaneously desperately trying to create inflation. From history we know, usually if a government wants to do this, eventually it will work. So the question is is gold a good way to protect yourself from an inflation?

Warren Buffett says no. That's why he likes to buy companies like Kraft because he says Kraft has something more valuable. It has pricing power. You can pass on any input cost pressures to the consumer. But Ray Dalio, the famous investor from Bridgewater, he says that's nuts. You want to own gold for sure because as governments try to inflate their way out of their debt, the value of fiat money collapses.

My view is what's really valuable to think about is the Chinese and the Russians are accumulating gold in huge amounts. And the question is why are they doing it? Their view is the effort to create inflation in the West will work and they would like to emerge as the only hard currencies in the world economy. They want to be able to say we actually have collateral behind our currencies. That's not true for next week or next your, but in the course of the next 20 years, they definitely would like to emerge as a more sound investable option than the US dollar might present.

Of course, from an American point of view, a policy maker in the US will say that's just insane. That's ridiculous. They've lost their marbles. From their point of view, what America is doing is also insane, ridiculous, and they've lost their marbles. There's an honest difference of opinion. I guess that's what investors have to think about. I do think it's got to be part of the portfolio somewhere.

Mike Gleason: Well Pippa, we really appreciate your insights and thanks for being so generous with your time. The book puts things into plain language when it comes to economic conversations. As our audience has just heard, you do a great job of doing that. They should definitely check out the book. We wish you continued success with that. Please tell people how they can get a copy of it.

Pippa Malmgen: Great, well it's on Amazon. You'll find it under Signals. Also have a look at that Fifty Shades of Economics series. It's on YouTube. Both of them are really designed to help people get engaged with the world economy, with things that you see every day. So I hope you enjoy it.

Mike Gleason: Thanks again for taking the time. I definitely hope we can do it again sometime soon. Thank you very much, Pippa.

Pippa Malmgen: Excellent. Thank you.

Mike Gleason: That will wrap it up for this week. Thanks again to Dr. Pippa Malmgen, founder of the DRPM Group and author of the book, Signals: The Breakdown of the Social Contract and the Rise of Geopolitics, which is available on Amazon.

Tune in next Friday for our next weekly market wrap podcast. Until then, this has been Mike Gleason with Money Metals Exchange. Thanks for listening and have a great weekend everybody.

Mike Gleason is a Director with Money Metals Exchange, a national precious metals dealer with over 50,000 customers. Gleason is a hard money advocate and a strong proponent of personal liberty, limited government and the Austrian School of Economics. A graduate of the University of Florida, Gleason has extensive experience in management, sales and logistics as well as precious metals investing. He also puts his longtime broadcasting background to good use, hosting a weekly precious metals podcast since 2011, a program listened to by tens of thousands each week.